Business Page – September 21,
2002

Lies, Damn Lies and Accountants!

Introduction

In
the wake of the death of Enron and its auditors Andersen all the limitations
and deficiencies of the accounting and auditing profession have been starkly
and embarrassingly exposed. The issue revealed the pursuit of self-interest
rather than self-regulation by accountants and auditors, profit before
professionalism, the unreliability of financial statements and the human
frailties of those who practise the magic of accounting. Accounting at least
in the public mind has displaced economics as the dangerous and imprecise
science in which profit becomes a subjective matter with a range of infinite
breadth. Figures that receive the unqualified stamp of approval in one year
are quietly and often stealthily restated – a euphemism for ‘changed’
– one year later. It was market reaction to Enron’s restatement of
earnings that led to its and Andersen’s gut-wrenching descent and swift
demise. Indeed the market wrote off Andersen long before it was actually
convicted of any wrong-doing.

Feigned
Innocence

Sound
accounting rules consistently applied and financial statements audited by
professionally qualified, independent auditors in accordance with strict
standards of auditing are indispensable in any market economy. Any doubts
about the credibility and reliability of the accounting rules, the auditing
standards and the integrity of the auditors and accountants involved
undermine not only those financial statements and the profession but the
entire investment and financial system. It is perhaps not surprising that
the profession has responded with feigned innocence ranging from “it
can’t happen here” in the UK to it is ‘really a problem of trust”,
“ this is not a problem with the accounting and auditing profession” to
‘Enron is an American problem”.

It
is hardly worth pointing out that very recently Marconi (UK), Vivendi
(France) and HIH Insurance (Australia) have had problems with their
accounts, that all the Big 5 Firms before Andersen operated worldwide and
that many of the companies involved operate trans-nationally. Even today as
I prepare this article from a hotel room in London, the Times reports that
Sodexho, a company which operates in Guyana has launched an attack on its
auditors, who also operate in Guyana, saying that their “statutory
auditors have not been sufficiently vigilant”. Another article also
reports that “US investigators have accused Cable and Wireless of entering
into secret deals with Qwest and Global Crossing, the stricken telecom
companies at the centre of fraud enquiries’. Guyana’s only response to
the crisis in the profession internationally has been a clumsy and
inconclusive attempt to censure one member of the profession who sought to
draw attention to some of the danger signs in corporate and professional
practices in the country!

Naiveté

It
does the profession no credit trying to claim that nothing is wrong with
accounting and that it is the misdeed of a few practitioners who simply
failed to follow the rules. That is at best naiveté and at worst an attempt
at obfuscation and to mislead the public once again. No less an authority
than the Financial Times of London stated quite emphatically recently that
“accounting goes to the heart of Enron’s failure” The accounting
profession is now in the dock and the daily fare of accounting scandals is
not helping its defence. It has shown itself weak in technical matters,
spineless in standing up to CEO’s and eager to sacrifice its integrity for
profits. Accounting is one of the few professions which require no minimum
university education while its much vaunted ethical standards do not seem to
have any firm foundation and are not part of the core curriculum of the
leading accounting examinations. The standard and perhaps only serious work
on the philosophy of audit is decades old and it is unlikely that many
accountants even know about it. Accountants move easily from watchdogs in
their capacity as auditors to being the architects of clever deals and
frauds as CFO’s and CEO’s.

Different
Results

The
public is led to believe wrongly that accounts signed off by auditors are
accurate. Auditors however understandably use a sample of transactions in
their audit and apply the materiality concept that focuses only on those
transactions and balances which can affect the fair presentation of the
financial statements. In this way it is possible for significant matters to
escape the attention of the auditor. The other relates to accounting
policies adopted by the company.Two
companies with identical transactions can in fact declare substantially
different results both of which may carry an unqualified opinion by the same
audit firm.

The
reason is that accounting standards allow for financial statements being
prepared using different conventions with respect to major balances. For
example, fixed assets can be depreciated using the straight line or the
reducing balance method. Inventory can be valued based on the last in first
out, average and the first in first out bases. One company can capitalise
its leases while another may expense its lease payments. Similarly one
company may capitalise certain costs while another may write off those costs
in the year in which they are incurred.

Accounting
Standards

Other
potential sources of confusion include the situation that different
accounting standards govern financial statements in the major market
economies. The USA uses GAAP while the international community other than
the UK (which has its own standards) applies International Accounting
Standards (IAS). You may think that this creates a problem for the auditor
whose different offices will sign off on the financial statements prepared
under different conventions, but it does not. The offices will have to
recognise the different accounting standards underlying the preparation of
those statements. It would therefore be highly unusual for accounts prepared
under these separate regimes to generate the same results.

Alternative
Policies

Non-US
members of the profession have argued that neither IAS nor UK accounting
standards would have permitted the substantial liabilities being kept off
the balance sheet of Enron or the exclusion of the millions of dollars worth
of option payments to the directors not being charged to the profit and loss
account. It is true that the profession in the UK had taken steps prior to
Enron to bring their reporting standards in line with IAS and it is likely
that those efforts will be accelerated. There are however differences some
of which suggest that IAS also have their problems. They allow companies to
choose between alternative policies on the same issue and in the case of
pension accounting “allow gains or losses to be ignored if they do not
exceed a corridor of 10% of the greater of the gross assets or liabilities
of the scheme” The USA has so far not announced any specific measures to
address the deficiencies in its accounting standards.

Larger
Issues

But
there are even larger issues with accounting which are yet to be resolved.
Here are some of them:

Income
recognition:
Companies still have discretion in the timing of recognition of income and
expenses. Enron is certainly not the only failed company to have manipulated
its income numbers. Global Crossing leased capacity to other telecoms
companies and recognised the income immediately while it treated similar
capacity leased from suppliers as capital expenses. Other companies
particularly in the computer business treat as sold and therefore recognise
as income deliveries to warehouse.

Off-balance
sheet items:
Companies and not only Enron use off-balance financing to keep
liabilities off its books. One familiar example is with respect to lease
financing so that a trucking operation or a shipping line may operate trucks
or ships that are effectively owned under lease terms but which it does not
bring into the books.

Share
Options:
The profession in the US has joined with big business in resisting attempts
to have the cost of options which is clearly an employment cost being
charged in the accounts. This could not happen under IAS or under UK
accounting standards.

Disclosure

There
is also the critical issue of disclosure of information and readers of these
columns will be aware of the open and deliberate practice of leading
companies which continue to flout the requirement for disclosure of
information required by company law and accounting standards. This column is
constantly pointing out the deliberate omission of information on
transactions with related parties and on segmental information in the
accounts of our leading companies and it remains a mystery that our auditors
can put their names to these financial statements. If they do not know that
the accounts do not comply with accounting standards then their professional
suitability as auditors is questionable, and if they do know then they are
clearly part of the conspiracy to conceal information from the shareholders.

The
Public Interest

Professional
accountants in their capacity as auditors must recognize that they have a
duty to protect the interest of the shareholders to whom in law they report.
No less a person then the CEO of the International Federation of Accountants
noted in his presentation to the international assembly of the accountants
in the UK that the first duty of the profession is the protection of the
public interest. Sadly, it seems that the first reaction of the profession
is to cover up and protect its membership rather than use its authority to
deal with improprieties thereby preserving its credibility. There is no
doubt that because of this desire to preserve the status quo,
self-regulation has failed miserably worldwide. This of course has led to
the introduction of sweeping legislative changes in the USA to correct the
situation.

Conclusion

Accounting
firms are often accused of using the audit as a loss leader (charging low
fees) to gain access to lucrative contracts in other areas which, as in the
case of Andersen/Enron, generate significantly higher fees than the audit.
Is disclosure of this type of information by the firms in the public
interest? The answer must be a resounding yes. The operations of the
accounting profession are shrouded in secrecy and firms are not subject to
any of the disclosure requirements enshrined in accounting standards. Maybe
the time has come for the profession to ensure full transparency so that the
perception of conflicts of interest or compromised independence and
integrity is erased from the minds of the public. Too often the profession
adopts the attitude that it is an exclusive group that can do no wrong and
should not be subject to scrutiny since it has its own regulations to deal
with wrongdoing by its members. It would be interesting to hear what those
investors who have lost their life savings feel about those regulations.